“Do Crises Weaken Vested Interests?”

Via Ezra Klein, a perhaps noteworthy paper from Simon Johnson, Todd Gorley, and Changyong Rhee titled “Do Crises Weaken Vested Interests? The Illustrative Case of Korean Corporate Bonds.” It’s about who can get bond financing in the wake of a major financial crisis:

Using a unique dataset of publicly placed corporate bonds in Korea, this paper assesses a bond market’s ability to provide financing during a severe bank crisis. Evidence from Korea after the 1997-98 crisis confirms that bond markets can develop quickly in bank-dominated economies. However, access was feasible only for the largest firms and, as with bank loans before the crisis, bonds were not allocated well. Large firms with weaker pre-crisis corporate governance were no less likely to obtain bond financing, and default risk was not priced by investors. This evidence suggests that while bond markets can develop quickly in a crisis-hit, bank-dominated economy, they may fail to allocate resources well in the absence of reliable credit rating agencies and when ‘too large to fail’ beliefs persist among investors. In terms of access to capital during the crisis, the largest firms did best and the financial playing field tilted further in their direction.

My guess is that this would be applicable to the United States. If, at the moment, you were interested in investing in corporate bonds you would probably have very little confidence in the credibility of the ratings agencies. And a reasonable person looking for a viable heuristic with which to assess the riskiness of lending to a firm will probably find it both easier and more significant to focus on the odds of the firm getting bailed out in the event of inability to pay than to try to do a detailed assessment of the business model. You’re looking, in other words, for a firm with a lot of political clout more than anything else. So as everyone becomes more dependent on the government, the vested interests grow stronger.